India's central bank maintained its policy repo rate at 8.0 percent, as expected, and again trimmed its statutory liquidity ratio (SLR) by 50 basis points to 22.5 percent but warned of upside risks to its inflation target that warrant "a heightened state of policy preparedness to contain these risks if they materialize."
The Reserve Bank of India (RBI) also cut the SLR in June by 50 basis points in anticipation of an improvement in economic activity and said the government's renewed commitment to a deficit of 4.1 percent of Gross Domestic Product had provide space "for banks to expand credit to the productive sectors in response to its financing needs as growth picks up."
The RBI raised rates three times by a total of 75 basis points since September 2013, most recently in January, and today omitted its statement from June that a faster-than-expected decline in inflation would provide it headroom to ease its policy stance.
India's consumer price inflation rate eased to 7.31 percent in June from 8.28 percent in May, continuing the decline from November's 11. 16 percent.
But RBI Governor Raghuram Rajan, underscored the upside risks and said the moderation in inflation in the last two months was due to base effects and a steady deceleration in consumer price inflation excluding food and fuel.
Rajan pointed to risks to inflation from the pass-through of higher administered prices, a possible rise in oil prices from geo-political concerns and exchange rate movements, and improving growth in the face of continuing supply constraints.
"Accordingly, the upside risks to the target of ensuring CPI inflation at or below 8 percent by January 2015 remain, although overall risks are more balanced than in June," he said, adding it was therefore appropriate to continue to maintain a vigilant policy stance.
Prospects for India's economy have improved modestly, Rajan said, with data showing a firming of industrial growth and exports, and the implementation of government policy should help create the conditions for a steady improvement in demand and supply conditions.
The central estimate of real GDP growth of 5.5 percent that was set out in the RBI's April projection for 2014/15 can be sustained, though the balance of risks could tilt to the downside if risks relating to the global economic recovery, the monsoon, and geopolitical tensions intensify, he added.
India's Gross Domestic Product expanded by 2.1 percent in the first quarter of the year from the previous quarter for annual growth of 4.6 percent, marginally down from 4.7 percent.
Global economic activity has also been picking up at a modest pace since its slowdown in the first quarter, with portfolio flows into emerging markets rising strongly.
"This implies, however, that EMEs remain
vulnerable to changes in investor risk appetite driven by any reassessment of the future path
of US monetary policy or possible escalation of geopolitical tensions," said Rajan.